Everything You Wanted to Know About Supplemental Capital But Were Afraid to Ask

Greetings from the icy confines of Albany, New York where the snow plows are busy salting the roads and the kids are back in bed, secure in the knowledge that they have the most magical of days – a snow day.For the rest of us, grab a second cup of coffee and let me tell you about supplemental capital.

Last Thursday, the NCUA released an Advance Notice of Proposed Rule Making asking a broad range of fundamental questions on which it would like the industry’s feedback as the Board tentatively considers whether it can and should offer supplemental capital.The ANPR follows up on a briefing staff provided the Board at its October meeting.Because the issues involved are complicated, and I actually do try to keep this blog fairly short, I am breaking this discussion into two parts.

First we need a little context.All credit unions are subject to net worth requirements.In addition, so called complex credit unions are subject to additional risk-based net worth requirements.NCUA now defines a complex credit union as one with $100 million or more in assets.As you may recall, after much angst, NCUA is imposing a risk-weighted capital ratio on these complex credit unions beginning in 2019.As an outgrowth of this discussion, credit unions called yet again for the expanded use of supplemental capital to help them meet their net worth requirements.The result is this ANPR.

What is supplemental capital?Right now, it does not exist.In its ANPR, NCUA defines it as including “any form of capital instruments credit unions that are not designated as low-income might be authorize to issue and count only for inclusion in the risk-based net worth requirements.”There is a lot packed away in this definition.First, it would only apply to complex credit unions since they are the ones that have to meet the risk-based requirements.This is because NCUA has concluded based on a plain reading of the law that it may only have the regulatory flexibility to allow additional capital for meeting the risk-based requirements.

Secondly, low income credit unions are already authorized to issue secondary capital and yes, there are complex credit unions that are designated as low income.This proposal would provide these credit unions an additional form of capital.

However, there are certain subtle distinctions between secondary capital as it exists today and supplemental capital as envisioned by NCUA.Most importantly, secondary capital is uninsured and must be subordinate to all other claims of the credit union, including the claims of creditors, share holders and the Share Insurance Fund.It also can only be provided by what the regulations describe as non-natural persons.Supplemental capital would also be uninsured and subordinate to claims from the National Credit Union Share Insurance Fund, but, not necessarily subordinate “to all other claims.”

Finally, supplemental capital would be a debt instrument classified as a security as a matter of federal law.This raises a host of potential issues, particularly for federally insured state chartered credit unions, which may have to get clearance from the IRS to ensure that supplemental capital does not put their tax-exempt status at risk.Remember that while both state and federal credit unions are tax exempt, their exemption derives from different parts of the code.

Now that I’ve provided you some of the basics, it’s time to dig into the plusses and minuses of this proposal.More on that tomorrow – I am sure you can’t wait.